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The Toughest Road for Pan American Silver

A trying time for one silver miner yields bargain-basement value.

Let's keep things in perspective here. The last time shares of Pan American Silver(Nasdaq: PAAS) careened to beneath $15 per share, near the height of the 2008 financial crisis, the price of silver had briefly slid beneath the company's total cost of production near $9.50 per ounce. As I noted at the time, this well-respected miner even volunteered a 10% temporary wage reduction for all senior executives in response to the gut-wrenching collapse in precious-metal prices.

Today, with silver prices far stronger near $27 per ounce, Pan American is positioned to yield roughly 25 million ounces of robustly profitable silver during 2012. But you'd never know it from the share price, and a recent downgrade of the stock from "buy" to "hold" by analysts at Deutsche Bank underscores the toughest road this Pan American has been forced to walk since the post-Lehman market collapse.

Last week, Pan American issued a statement in response to draft legislation pending before the Argentine province of Chubut, where Pan American's flagship development project, called Navidad, has awaited approval to begin construction. Although the draft legislation would clear the regulatory road for Navidad to move forward, it comes with decidedly arduous strings attached that, in the company's words, "will render the Navidad project uneconomic at any reasonable estimate of long-term silver prices."

From the 3% net smelter royalty (NSR) previously contemplated, the legislation would increase that royalty obligation to an 8% NSR. Additionally, a resource company owned by Chubut province would receive 4% of total sales and "a 7% direct carried net pre-tax profit interest" in the operation. Taken in sum, and on top of further proceeds payable to Argentina's national government in the form of a 35% corporate tax rate and 10% export duty on metal concentrates, the measures leave slim pickings behind. Pan American did not mince words when declaring that "if the draft law is passed as submitted, there can be no other choice currently than to stop investing further in the project." Pan American's dealings with Argentina's Chubut province are beginning to resemble Kinross Gold's (NYSE: KGC) tough negotiations with Ecuadorian officials concerning the now-temporarily shelved Fruta del Norte project.

More broadly, Argentina has injected several shocks of uncertainty into the landscape for miners over the past year, which had certainly contributed to the malaise in Pan American's stock even before the latest round of difficulty. The country now requires miners to repatriate all export revenue back into Argentina, and the controversial decision to nationalize the Argentine assets of Spanish oil company REPSOL set a worrisome precedent, even though odds of further nationalizations are thought to be low. As Argentina's perceived attractiveness for mining investment waned, and the entire mining complex suffered a deep and ongoing correction, Yamana Gold(NYSE: AUY) pounced on the opportunity to acquire Extorre Gold(NYSE: XG)at an attractive valuation. Barrick Gold(NYSE: ABX), for its part, concedes no impact upon its Pascua-Lama mine-construction project now that environmental legislation designed to protect glaciers was upheld last week by Argentina's highest court.

I find it remarkable that my December 2007 CAPScall for Pan American Silver has underperformed the S&P 500 by 48% even as the silver price has nearly doubled since that time. While some portion of the stock's dramatic collapse over the trailing year finds context in the difficult road the company has walked of late, I encourage Fools to consider the resulting valuation even under a worst-case scenario in which the Navidad project is forced onto the back burner. When I see a road grow this difficult to traverse, I begin to look for an eventual smoothing of the terrain.